Consumer price sensitivity rises

Consumers are becoming notably more price sensitive, with a number of important implications.

We can observe this increased sensitivity in a few ways:

• U.S. consumer spending and retail sales were more conservative in the latest month, suggesting disdain for high prices.

• The latest U.S. Beige Book reports that “contacts in most Districts noted consumers pushing back against additional price increases.”

• Major corporate executives have repeatedly noted more price-sensitive consumers in their comments.

• Now, a variety of major consumer-facing companies are announcing price cuts.

Examples of these price cuts abound. Fast-food retailers McDonalds and Burger King have both announced new US$5 value meals. Target has announced price cuts on 5,000 common goods. Walmart is purported to have cut prices on almost 7,000 products.  Amazon Fresh, Aldi and Walgreens have also announced price cuts, as have others. 

Some portion of these announcements may amount to marketing – there are always a variety of prices falling and others rising within a giant retailer, and it looks good to highlight falling prices. But even this says something, as announcing price cuts is only a good marketing strategy if consumers are especially attuned to prices.

We can see in the price microdata – extremely granular product-level pricing data collected by statistical agencies – that the size of economy-wide product price increases has fallen back somewhat from their peak, and – even more importantly – the frequency of such price increases has fallen quite a bit. That said, in both cases the pricing behaviour has not yet fully returned to normal.

While businesses are setting prices, they are of course attuned to material costs, labour costs, interest rates and so on. But the number one consideration, according to joint research by a number of regional Federal Reserve banks, is the strength of demand. As the U.S. economy has decelerated, that is the best single argument for company pricing to change in a way that allows inflation to decelerate.

There are several positive consequences of a more price-sensitive consumer:

• Product prices rise more slowly, helping inflation come down.

• Consumers, in turn, get a better deal on products.

• Just as importantly, these corporate price cuts are an endorsement of the soft-landing narrative: inflation can fall further, and the economy is slowing somewhat as consumers pull back.

Of course, there are also negatives. Consumer caution reflects, at least in part, distress from higher interest rates. For investors, this greater consumer price sensitivity promises to weigh on the profit margins of consumer-oriented businesses.

A caveat is also in order. The high inflation that remains in the system is primarily a function of rising service prices, not goods prices. Goods prices are already roughly flat. Declining goods prices at retailers and fast-food restaurants do not thus directly address the main source of price pressures.

Of course, it is normal for goods inflation to run cooler than service inflation. One can also achieve normal inflation with falling goods prices that pair with robust service inflation.

Easing cycle continues

The global monetary easing cycle continues to gain steam. After a variety of emerging-market central banks undertook rate cutting earlier in the year, the central banks of Switzerland and Sweden initiated easing on the developed-world side of the ledger.

 Now, in the past week, the European Central Bank (ECB) and Bank of Canada have joined in, with initial 25-basis-point rate cuts. Both are likely to progress somewhat further over the remainder of the year. Markets price in an additional rate cut by year end for the ECB from its new resting point of 3.75%. Opinions split between September versus December as the most likely trigger points. We would take the earlier of the two and flag the possibility of an additional cut.

In Canada, the overnight rate fell from 5.00% to 4.75% as the Bank of Canada opted to take advantage of receptive market pricing to push through its first rate cut (see next chart). We had long favoured July as the logical starting point on the presumption that the Bank would wish to properly signal the coming cut in advance (much as it had previewed its first hike in 2022). But Canada’s slightly soft Q1 gross domestic product (GDP) print of +1.7% may have tipped the balance toward June.

Bank of Canada embarks on rate cut as inflation continues to ease

As of 06/06/2024. Shaded area represents recession. Sources: Haver Analytics, Macrobond, RBC GAM

To the extent there was a surprise in the Bank of Canada’s decision, it was its apparent openness to another rate cut at the next opportunity. Governor Macklem refused to rule out a July move if the data proved supportive. Of course, that leaves considerable ambiguity around just how remarkable or pedestrian the data needs to be to warrant a second consecutive rate cut.

Remarkably, markets price in a 55% likelihood of a rate cut for July 24. That feels awfully high given that other developed-world central banks are maintaining or are expected to maintain fairly large gaps between their rate actions. The Bank of Canada is certainly in a position to ease further, but perhaps September makes more sense, with December a potential third cut.

Two further questions immediately emerge about Canadian monetary policy.

1. How far might the Bank of Canada get ahead of the U.S. Federal Reserve (Fed) in rate cuts? There is no hard limit. The Bank of Canada just needs to be aware – and it is – that rate cuts in a small open economy come two for the price of one. The rate cut does its own work, while a currency response can provide a further boost to growth and inflation.

   Monetary policy is usually quite similar in the two countries, but with exceptions when one country deviated from the other by up to around two percentage points (see next chart). Extremes include 2003 (when Canadian rates were two percentage points higher), 1997 (Canadian rates were about 2.5 percentage points lower) and 1995 (Canadian rates were about two percentage points higher).

   In more recent memory, the Canadian policy rate spent the entirety of 2011—2014 a percentage point higher than in the U.S. One might imagine a similarly sized gap to that episode forming over the coming year.

Monetary policy in Canada and U.S. sometimes deviates moderately

As of 06/10/2024. Shaded area represents U.S. recession. Sources: Bank of Canada, U.S. Federal Reserve, Macrobond, RBC GAM

1. Might Canada’s home prices suddenly explode higher now that the cork has been popped on rate cuts? Just how much pent-up demand was waiting for the prospect of cheaper financing? A Royal LePage report from February estimated that 56% of would-be homebuyers were sitting on the sidelines, waiting for better conditions. Of course, a single 25-basis-point rate cut doesn’t greatly change the affordability equation – all the more so when the rate cut was broadly anticipated and so already priced into bond yields. Realtors quoted in the press don’t appear to expect a huge change in behaviour.

   But as a leading indicator for further rate cuts to come, the Bank of Canada’s first move does take on an outsized significance. As a result, we anticipate a certain amount of renewed interest, but still budget for home prices that go roughly sideways. There is admittedly more uncertainty than usual around the subject as this gets sorted out.

Incidentally, and released after the Bank of Canada’s decision, May employment in Canada rose by a slightly-above-consensus 26,700 position (versus 22,500 consensus). This is about as close to a bull’s eye as Canada’s job number estimates ever get. Although the amount of hiring compares favourably to the long-term historical norm, it isn’t enough to absorb the country’s massive population growth right now.

On that note, Canada’s population growth in the first quarter of 2024 was recently reported at a big +241,494. That’s the fifth fastest quarterly population gain of the past 50 years, while simultaneously being the slowest in the past year! While it is normal for the final quarter of the year to experience especially fast population growth, it is surely still notable that the rate of increase slowed from a wild +430,635 in the fourth quarter.

With so many new job seekers, the unemployment rate rose again, from 6.1% to 6.2% (see next chart). The details of the report were mixed, with full-time employment down 35,600 positions. Wage growth, however, has accelerated from +4.8% to +5.2% YoY.

Canadian unemployment rate low but rising

As of May 2024. Sources: Macrobond, RBC GAM

On a similar note to the rising Canadian unemployment rate, Canadian GDP per capita continued to shrink. This was also mainly due to the population surge (see next chart).

Canadian GDP per capita has been shrinking

As of Q1 2024. Sources: Statistics Canada, Macrobond, RBC GAM

U.S. data evolves

Strong payrolls

European Central Bank (ECB) and Bank of Canada rate cuts revved up market expectations for the U.S. Fed to ease in September. However, the closely watched U.S. payrolls report gave a nudge in the opposite direction.

The 272,000 jobs added in May handily exceeded expectations for 180,000 new positions, as did hours worked and wage growth (see next chart). This above-consensus outcome was in line with our expectations. The result was hardly startling when job creation prior to that point in 2024 had averaged a similar +242,000 new jobs per month. Overall, it was a pretty good report that argues the U.S. economy is still fine.

U.S. labour market sends mixed signals

As of May 2024. Z-score of month-over-month % change of U.S. employment from non-farm payroll and Labor Force Survey (LFS) and aggregate hours worked based on data since 1984. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

Pessimists could note that the alternative household survey instead reported the loss of 408,000 jobs in May. But it is by far the more volatile survey and has serially underestimated job creation – due, we think, to an underestimate of illegal immigration.

One might also observe that job creation in the payroll survey skewed toward non-economically sensitive sectors such as health care, education and government services. Job openings also continue to edge lower – though they are still healthy – and weekly initial jobless claims, while low, are inching slightly higher (see next chart).

U.S. jobless claims remain low

As of the week ending 06/01/2024. Sources: U.S. Department of Labor, Macrobond, RBC GAM

Although the unemployment rate ticked higher from 3.9% to 4.0%, the U.S.-based Sahm Rule has still not been triggered (see next chart). The rule is that when the three-month average of the U.S. unemployment rate has increased by 0.5 percentage points relative to its low during the previous 12 months, a recession has always followed in short order. The increase in the trend unemployment rate still falls just short of that. But should the unemployment rate edge even a tenth of a percentage point higher over the next few months and then stick there, that would be sufficient to trigger the rule.

Unemployment increase approaches unchartered territory without recession

As of May 2024. Unemployment rate is 3-month moving average. Sources: U.S. Bureau of Labor Statistics, National Bureau of Economic Research (NBER), Macrobond, RBC GAM

Realistically, the U.S. unemployment rate will probably continue to rise in the coming quarters. After all, we budget for below-potential economic growth and furthermore believe that a normal, sustainable unemployment rate in the U.S. is between 4.0% and 4.5%. So the Sahm Rule will probably be triggered by the fall.

The real question is thus whether we believe the Sahm Rule constitutes an ironclad recession signal. The answer here is “no.” There is nothing mechanical about the rule that forces a recession. In fact, the Sahm Rule does not work in other countries: the Canadian unemployment rate, as an example, has already increased by well over a percentage point from its low, without prompting a Canadian recession.

We believe future economic cycles could be less volatile than in the past for a number of reasons,  including a diminished inventory cycle and a bigger service sector. The U.S. economy already broke through a similar warning threshold called “stall speed” in late 2022, without inducing a recession.

More generally, quite a number of historically proven recession signals have already failed this cycle, including metrics that track lending standards and global trade. Rules were made to be broken.

Of course, we do not reject the possibility of a recession altogether, with a probability over the next year of 35% – two to three times higher than normal. The Sahm Rule may yet be right.

Another labour market indicator sending worrying signals is the ongoing decline in temporary employment (see next chart). But the decline in temporary employment has now fallen so far and lasted for so long that it no longer really resembles the brief dips that usually precede a recession. We posit that hiring practices have changed, with businesses now preferring permanent employees after having struggled to find and retain workers in recent years.

Falling U.S. temporary employment would normally have induced a recession already

As of May 2024. Shaded area represents recession. Sources: BLS, Macrobond, RBC GAM

Twin reports from the Institute for Supply Management (ISM)

April brought dismal data for the ISM manufacturing and ISM services indices. Both fell below the critical 50 threshold that separates expansion from contraction. May was somewhat kinder (see next chart). The ISM Manufacturing Purchasing Managers’ Index (PMI) is still weak and actually fell slightly further.

But this is not an especially new development. The metric has been in mild contraction mode for the bulk of the last year and a half. It is actually higher now than it was for most of that period.

U.S. manufacturing activity contracting while services sector continues to expand

As of May 2024. Shaded area represents recession. Sources: Institute for Supply Management (ISM), Macrobond, RBC GAM

Instead, the worrying development in April had been the descent of the ISM services index. Fortunately, May brought a big bounce in the metric, from just 49.4 all the way up to 53.8. This gap may not sound large, but it represents the difference between mild contraction and moderate expansion. 

Tying it all together

The closely watched Federal Reserve Bank of Atlanta GDP nowcast has swung violently in recent weeks. In early May, it anticipated as much as 4.2% annualized Q2 GDP growth for the U.S. – a monster number. At the start of June, it then expected just 1.8% growth – a slightly weak print. Today, it anticipates just over 3% growth – a robust outcome, if actually achieved. These wild gyrations are not so much a failure of the model as a reflection of the volatility and contradiction within recent high-frequency data points. Trade is a particular source of expected weakness, while inventories are a particular source of expected strength.

The consensus annual growth forecast for 2024 in the U.S. has been edging slightly higher in recent months, while the 2025 outlook has been steady but muted (see next chart).

U.S. consensus growth forecast revised up for 2024

As of May 2024. Sources: Consensus Economics, RBC GAM

U.S. economy has busy week ahead

The U.S. economy is busy over the week ahead, with June 12 hosting what are arguably the two most important economic developments of the month: the next rate decision by the Fed and the next Consumer Price Index (CPI) print.

U.S. Federal Open Market Committee (FOMC) decision

There isn’t much controversy around the federal funds rate, which is set by the FOMC. It’s the interest rate at which commercial banks borrow and lend their extra reserves to one another overnight. Markets assign just a one in a hundred chance of a surprise rate cut at the FOMC meeting this week. July also appears unlikely based on recent signaling and still-warm inflation. Recent Fed speeches have tilted in a hawkish direction that seeks to reduce market pricing for rate cuts (successfully, it should be added). The most recent Fed minutes were similarly less accommodating than expected going into the release.

The real debate revolves around the dot plots that will be released alongside the decision. The median FOMC participant had previously forecast two 25-basis-point rate cuts by the end of the year. The obvious debate today is whether that might get pared back to a single rate cut. Based on the verbiage coming from the Fed, this seems likely. The median dot plot will probably be one cut, but with a scattering of forecasters still anticipating two cuts, and a sizeable minority of participants assuming no cuts at all. We are sympathetic to a September rate cut, and hopeful that inflation may cooperate enough to eventually reintroduce a second cut to expectations – but not just yet.

May CPI

You will recall that April CPI marked a welcome if slight improvement in the U.S. after several months of worsening inflation. It is critical that inflation continue to ease in May (when the numbers become available) and, ideally, beyond.

Fortunately, real-time inflation metrics from PriceStats (see next chart), Truflation and the Cleveland Fed (see subsequent chart) all predict further improvements.

U.S. Daily PriceStats Inflation Index improves

U.S. Daily PriceStats Inflation Index as of 06/07/2024. CPI as of April 2024. Sources: State Street Global Markets Research, RBC GAM

U.S. inflation nowcasting (month-over-month % change)

As of 06/10/2024. Sources: Federal Reserve Bank of Cleveland, Macrobond, RBC GAM

At present, and in the context of the aforementioned indicators, the consensus forecast seems about right. It anticipates a mere 0.1% monthly price increase for overall inflation (falling oil prices help), versus a 0.3% increase in core inflation. Core inflation is the key. It had been stuck rising at 0.4% per month earlier in the year, before declining to 0.3% in April.

Realistically, May’s numbers (when they’re reported) will probably bring the same. That’s still too hot, of course, but progress. Conversely, an upside miss would be devastating and call into question the declining inflation narrative, while a 0.2% print would supercharge the story of normalizing inflation. For what it is worth, 52 forecasters call for a 0.3% core reading and 10 call for a 0.2% core.

We are still hopeful that shelter inflation will continue to gradually ease. We’re also hopeful we’ll see a turn before too long in spiking insurance inflation. An upside risk extends from shipping costs, which have begun to increase again as bottlenecks in the Red Sea and the Suez Canal prove complicated (see next chart). But the problem remains far more minor than in 2021 and 2022.

Shipping costs have started to rise after seasonal lull

As of the week ending 05/23/2024. Sources: Drewry Shipping Consultants Ltd., Macrobond, RBC GAM

U.S. election update

It is now T-minus five months to the U.S. election, and so worth a check-in from an economic standpoint. A few items leap out.

The first is that the race once again marginally favours Trump over Biden. The race had narrowed in April as Biden rose in the polls. It certainly still remains close, but all four metrics we examine now show Trump to be the more likely victor on November 5 (see next chart).

2024 U.S. presidential election forecasts show close race with Trump slightly ahead

All data as of 06/03/2024. RealClear Politics poll averages for Biden vs. Trump matchup only. Others acknowledge possibility of other candidates contesting the election. Predictit probability of winning derived from prediction markets data. Oddschecker probability of winning derived from median daily betting odds. Five ThirtyEight weighted averages of national presidential polls. Sources: ABC News, the Five ThirtyEight, oddschecker, Predictit, RealClearPolitics, Macrobond, RBC GAM

In Congress, the Senate and the House of Representatives both appear set to flip to the opposite party, putting the Democrats in charge of the House and the Republicans in charge of the Senate. We had previously noted that if Congress were to unexpectedly align both chambers in favour of a single party, it was more likely to be for the Republicans. That’s no longer clear today – such a scenario could go either way. A unified Congress would be the best chance of either presidential candidate delivering their full unvarnished policy platform (and also running up the debt further).

On the legal front, Trump was recently found guilty in the first of his four criminal trials. He will be sentenced on July 11. While the conviction could theoretically come with jail time, in practice this is unlikely. Furthermore, he is certain to appeal the ruling (and apparently has a fighting chance at winning given the unconventional legal strategies pursued against him). That should stretch the case beyond the election.

Trump’s three other criminal trials are unlikely to begin before the election. As such, nothing precludes Trump from contesting the presidency or taking office if he wins. It would normally be a disadvantage to lose precious campaigning time to court dates, let alone to be accused of a crime, but it has actually bought Trump a great deal of media attention and bolstered his anti-establishment reputation, with the result that his campaign donations surged as his first court case played out in May.

For his part, Biden has attempted to short-circuit criticism that he is soft on illegal immigration by signing an executive order that would greatly limit the ability for people to seek asylum if they have crossed the border illegally. But this would appear to be more of a signal to voters than a genuine policy shift, as the executive order is likely to be rejected by the court. The White House had previously attempted to pass immigration reforms through the legislative process, but that remains tied up in Congress. Illegal immigration is a top issue in the election, and Americans have significantly soured on the topic over the past half decade. The flow of immigration is an important input for determining economic growth.

Biden also recently introduced another round of tariffs against China – a point of broad similarity between the two candidates. The tariffs target mostly green technologies including electric vehicles, certain batteries, solar panels and a range of other products. All else equal, tariffs usually weaken both the domestic and the foreign economy. They tend to increase domestic prices and strengthen the domestic exchange rate. But they can also shield strategic domestic industries, which appears to be the objective here.

Finally, and framed with the observation that neither Biden nor Trump appear to care much about balanced budgets or to be at all perturbed by the enormous fiscal deficit currently hanging over the U.S., the 2024 fiscal impulse is currently neutral. This is to say, the size of the deficit in 2024 tracks the 2023 deficit very closely (see next chart). That means the fiscal situation is neither supporting nor subtracting from growth. Last year, there was a considerable (and surprising) fiscal boost when the deficit was considerably larger than the year before.

U.S. budget deficits in 2024 have closely tracked 2023 levels so far

As of April 2024. Cumulative deficits over each fiscal year. Sources: U.S. Department of Treasury, Macrobond, RBC GAM

Gold prices rise

The price of gold has increased considerably over the past three months, reaching a new high of US$2450 per Troy ounce in May (see next chart).

Gold price has increased

As of 06/07/2024. Sources: Macrobond Financial AB, Macrobond, RBC GAM

This advance is initially counterintuitive. Although inflation remains elevated, gold’s recent movement isn’t obviously a function of inflation, given that inflation is actually much better behaved than it was in 2021—2022, when gold prices were lower and moving roughly sideways.

Gold’s strength also isn’t obviously a function of elevated risk aversion, as other risk assets such as equities have performed well over the same time period.

Furthermore, gold prices should theoretically be challenged at a time of elevated interest rates, as gold doesn’t pay a coupon of its own.

So what is going on? Arguably four other things:

1. With interest rates starting to fall, gold becomes less unattractive on a yield basis.

2. Even though inflation can probably fall further from here, this isn’t guaranteed. Gold (or any number of other commodities, real assets or real-return bonds) provide a theoretical hedge against that scenario. There is certainly some value in that.

3.  Although not fully justified by the facts on the ground, there is a perception that this is a time of great turmoil and uncertainty. Costco – a membership warehouse – is now somewhat improbably offering bars of gold alongside its famous $1.50 hotdogs – and apparently selling them in significant numbers to people anxious about the state of the world.

4.  By far the strongest argument in my view, international central banks are loading up on gold (see Chinese gold reserves in next chart). As the dollar is weaponized, as the U.S. loses a modicum of its reserve currency luster and as international trust declines, central banks and governments are keen to own a safe asset that cannot be taken away from them even under the most adverse circumstances. Gold can serve that role. Central bank gold reserves have now increased by more than 1,000 tons in each of the past two years. This buying trend isn’t obviously about to stop.

China’s gold reserves are rising

As of May 2024. Sources: People’s Bank of China, Macrobond, RBC GAM

In turn, gold may continue to enjoy support due to ongoing governmental demand. But it is worth remembering gold’s shortcomings for non-governmental actors, including the fact that it provides no yield, it theoretically generates a 0% real return over the long run, and it has failed to reliably protect against inflation or financial market volatility in recent years.

Financial stress rising for Canadian consumers

As we had predicted a few months ago, an earlier spike in Canadian business bankruptcies is now beginning to reverse (see next chart). This is because much of the increase had been the result of a subset of small Canadian businesses proving incapable of repaying pandemic-era government loans that came due early in 2024. Once this wave has passed, we will have a sense for the true underlying trend. It seems reasonable to imagine that business bankruptcies are probably still rising beneath the surface – mainly due to the pain of higher interest rates – but much less profoundly.

Business bankruptcies in Canada spiked, but now ebbing

As of March 2024. Shaded area represents recession. Sources: Haver Analytics, RBC GAM

Canadian households, on the other hand, are beginning to feel some genuine pain. The clearest picture of this comes from delinquency data, which shows rising household delinquency rates across a range of loan types (see next chart). Fortunately, the rate of increase is fairly gradual and the absolute level of delinquencies is still fairly tame in the grand scheme.

Financial stress for Canadians has intensified

As of Q4 2023. Share of the number of accounts 90 days or more past due over the previous three months. Sources: Equifax, Canadian Mortgage and Housing Corporation, RBC GAM

The Canadian personal bankruptcy trend is somewhat more concerning, though not entirely transparent (see next chart).  Due to legislative changes in 2009, traditional Canadian consumer bankruptcies have been in structural decline and bankruptcy proposals have risen to take their place. We thus shouldn’t make too much of the gradual upward trend in the proposals line over the past 15 years, because much represents this structural change. But the recent sharp increase suggests some measure of actual pain, even if the total number of insolvency proposals filed by Canadians numbers just 9,000 over the past year – out of a population of more than 41 million.

Canadian consumer insolvencies have been rising

Bankruptcies and proposals as of March 2024, mortgages in arrears as of Feb 2024. Shaded area represents recession. Sources: Haver Analytics, Macrobond, RBC GAM

-With contributions from Vivien Lee, Vanita Maharaj and Aaron Ma